The ISO Terrorism Exclusions: Background and Analysis

February 2002

In this article, IRMI reviews
the evolution of the ISO terrorism exclusions, explains exactly
what is excluded, and provides the approval status of these exclusions
by states and other regulatory organizations.

The destruction of the World Trade Center on September 11, 2001,
represents the largest single insured event in history. Knowledgeable
estimates of total covered losses—property, general, and aviation
liability, workers compensation, life—range from $30 billion to
as much as $70 billion. Liability claims are the slowest to emerge,
and have been slowed even further by calls from attorney groups
for a "moratorium" on lawsuits stemming from the attacks, and by
proposals for a federal compensation program for the families of
victims. (One element of such a program would be a waiver of legal
action by recipients as a condition for receiving benefits.) No
matter how the final figures shape up, September 11 will easily
overshadow the next largest insured disaster: the $19 billion in
losses caused by Hurricane Andrew in 1992.

The scope of the disaster, and the disturbing ease with which
the attack was apparently carried out, struck a devastating psychological
blow to the international insurance industry, which had already
begun to respond to mounting losses by raising rates and imposing
restrictions on coverage. Well before the renewal of reinsurance
treaties on January 1, 2002, reinsurers announced the imposition
of new terrorism exclusions as a condition of coverage.

Faced with an inability to spread the risk of terrorist attacks
through the worldwide reinsurance network, domestic insurers sought
relief on two alternative fronts: governmental action to fill the
void left by the reinsurers; or contract language that would exclude
injury and damage caused by acts of terrorism. (Initial moves by
some insurers toward invoking standard war exclusions as a basis
for denying coverage in the September 11 attacks were quickly abandoned.
See "Attack on America: The Insurance
Coverage Issues" for a detailed discussion of insurance policy
war exclusions and terrorist acts.)

In November, Insurance Services Office, Inc. (ISO), made an initial
filing of exclusionary language that would address injury and damage
from terrorist acts. A number of insurers had already by this time
drafted their own similar terrorism exclusions. As it became more
and more likely through December that Congress would not be able
to reach a consensus on providing a federal "backstop" to insured
terrorism losses, state insurance departments began examining the
various approaches taken by ISO and individual insurers with regard
to terrorism. In consultation with state regulators, ISO revised
its original terrorism filing, limiting the exclusion to specifically
catastrophic losses.

When the first session of the 107th Congress adjourned in December
without passing any of the federal reinsurance proposals that had
been introduced, the insurance industry acted quickly on the second
of its alternatives: excluding terrorism losses from coverage in
standard property and casualty insurance policies. On December 21,
the National Association of Insurance Commissioners (NAIC) endorsed
the revised ISO language and recommended its approval by state insurance
departments. Those filings, which have to date been approved—and
implemented—in 45 states, the District of Columbia, Puerto Rico,
and Guam, are the subject of the rest of this article.

The Evolution of the ISO Terrorism Exclusions

ISO filed the first version of exclusionary language for use
with standard commercial property and liability policies in mid-November.
Unlike most ISO filings, which allow several months for regulatory
approval and company implementation, the terrorism filings were
made with a proposed effective date of January 1, 2002—the date
on which many reinsurance treaties would renew, presumably with
exclusions for loss arising from terrorism.

ISO's approach in the initial filings was simply to replace the
war exclusion, as it currently exists in different forms in commercial
property and commercial general liability coverage forms, with new
exclusions pertaining to both war and "terrorism." With respect
to property coverages, the proposed exclusion applied to:

loss or damage caused directly or indirectly
by terrorism, including action in hindering or defending
against an actual or expected incident of terrorism.
Such loss or damage is excluded regardless of any
other cause or event that contributes concurrently
or in any sequence to the loss.

In the version intended for general liability coverages, the
exclusion applied to bodily injury, property damage, and personal
and advertising injury:

arising, directly or indirectly, out of "terrorism,"
including any action taken in hindering or defending
against an actual or expected incident of "terrorism"
regardless of any other cause or event that contributes
concurrently or in any sequence to the injury or
damage.

Both sets of filings—property and liability—used the same definition
of "terrorism":

"Terrorism" means activities against persons,
organizations or property of any nature:

That involve the following or preparation for
the following:

Use or threat of force or violence;

Commission or threat of a dangerous
act; or

Commission or threat of an act
that interferes with or disrupts
an electronic, communication, information,
or mechanical system; and

When one or both of the following applies:

The effect is to intimidate
or coerce a government, or to cause
chaos among the civilian population
or any segment thereof, or to disrupt
any segment of the economy; or

It is reasonable to believe
the intent is to intimidate or coerce
a government, or to seek revenge
or retaliate, or to further political,
ideological, religious, social or
economic objectives or to express
(or express opposition to) a philosophy
or ideology.

The broad scope of these original ISO terrorism filings paralleled
that of exclusionary language already being developed and used by
some individual insurers. For example, one major commercial insurer
began endorsing its property policies at the end of the year with
an exclusion of:

any act of one or more persons, whether known or unknown and
whether or not agents of a sovereign power, for Terrorist Purposes
…

…Terrorist Purposes means the use or threatened use of any unlawful
means, including the use of force or violence against any person(s)
or property(ies), for the actual or apparent purpose of intimidating,
coercing, punishing or affecting society or some portion of society
or government.

The problem with language like this—or the language of the original
ISO filing, which it resembles closely—is that it is broad enough
to encompass even an act of simple vandalism if ideological or coercive
motives can be seen in it. Under the original ISO language, damage
caused by a brick thrown through the window of a political party
headquarters by a member of the opposing party would be an excluded
act of terrorism. In response to criticisms of this kind—and to
charges from some state regulators that the language in question
could even be used to deny insurance coverage to victims of hate
crimes—ISO decided to amend its filings.

The most significant of the amendments was the imposition of
two quantitative thresholds for triggering the exclusion. The threshold
is designed to make the exclusion applicable only when the terrorist
act causes catastrophic injury or damage. A property damage threshold
was set at $25 million, including both direct damage and business
interruption. A bodily injury threshold was also imposed—50 or more
persons killed or seriously injured. Only when one or both of these
thresholds are met does the terrorism exclusion apply—but then it
applies to all injury and damage caused by the terrorism, both below
and above the threshold. (A second amendment to the ISO filings
was made in late December, specifying that the $25 million property
damage threshold is applicable only to insured damage.)

With the imposition of a threshold came the need to specify rules
for measuring that threshold. Accordingly, ISO defined in the revised
exclusions what constitutes a single "terrorism incident," since
both the bodily injury and property damage thresholds apply on what
may be termed a "per-incident" basis. (Further motivating ISO to
address this point in its filings may have been the suits and counter-suits
filed by the World Trade Center leaseholder and its insurers, disputing
whether the plane crashes that brought the buildings down were one
occurrence of property damage, or two.) The ISO definition of a
single terrorism incident is expressed as follows:

Multiple incidents of "terrorism" which occur
within a 72 hour period and appear to be carried
out in concert or to have a related purpose or common
leadership shall be considered to be one incident.

In its amended filings, ISO also revised the definition of "terrorism"
to remove terminology that could invite dispute or that required
too subjective an application. For example, the original reference
to "chaos among the civilian population" was dropped, perhaps to
avoid arguments over what constitutes "chaos." Likewise, "revenge
or retaliation" as one of the triggering motives for "terrorist"
acts was dropped, since it was needlessly specific and added nothing
to the scope of the definition.

Finally, additional provisions regarding terrorism that involves
the use of nuclear, chemical, or biological weapons were added to
the exclusions, in light of the anthrax incidents that had followed
on the events of September 11 and growing fears that known terrorist
groups might have or be seeking access to nuclear weapons.

The ISO terrorism exclusions for both commercial property and
general liability policies were filed in their final amended form
in late December 2001, and state regulatory approval began almost
immediately, to implement the exclusions' use as quickly after January
1, 2002, as possible.

What the Exclusions Exclude

It should be noted here that the new exclusions filed by ISO,
and already being used in 45 states, are technically not just "terrorism"
exclusions. For property policies, the endorsement is entitled "Exclusion
of War, Military Action and Terrorism." The endorsement for use
with CGL policies is entitled "War or Terrorism Exclusion." Both
endorsements combine a terrorism exclusion with the standard war
and military action exclusion already found in commercial property
causes of loss forms.

The net effect on coverage under a standard commercial property
policy, therefore, is limited to terrorism claims (since the war
exclusion is identical to the one already applicable to the same
policy). For some other property lines (e.g., commercial crime),
the endorsement will arguably impose a broader war exclusion as
well as imposing a new terrorism exclusion. With respect to the
CGL policy, which excludes only contractually assumed war risks,
the "war or terrorism" exclusion will significantly restrict coverage
for liability arising out of war. On the assumption that the new
ISO exclusions (or their equivalent) will be attached to most new
commercial property and liability policies, the "war" portion of
the exclusions alone will mean a considerable narrowing of coverage.

With respect to incidents that meet the exclusions' definition
of "terrorism," there will now be no coverage of damage to insured
property under the following circumstances:

When nuclear materials are used in the terrorist
act

When the terrorist act consists of the "dispersal
or application" of chemical or biological weapons—that
is, chemicals or biological materials that are poisonous
or cause disease

When poisonous or disease-causing chemicals
or biological materials are released by a terrorist
act in such a way that it appears the release was
one purpose of the act

The distinction drawn by the second and third categories above
is between a terrorist act that involves the direct release of a
chemical or biological agent (such as the mailing of anthrax-contaminated
letters); and the use of non-chemical, non-biological terrorist
tactics to cause such a release (for example, the terrorist bombing
of a military facility where chemical or biological agents are stored).
Terrorism under either of these sets of conditions, or when nuclear
materials are involved, is excluded
regardless of the scope of the resulting injury or damage.
Under any other scenario involving a release of biological or chemical
agents - where, for example, it appears that the release is an
unintended result of other terrorist
acts—the exclusion applies only when a property damage threshold
(see next paragraph) is met.

With respect to terrorist incidents that do not fall into one
of the three categories listed above—that is, non-nuclear, non-chemical,
non-biological—the exclusion in property policies is triggered when
the total insured damage (including business interruption losses
sustained by owners and occupants of the damaged property) exceeds
$25 million. It is important to understand that, when applying this
threshold, all insured property damage under all policies written
by all insurers for all insureds is totaled. Thus, the exclusion
may be applicable even to an insured with far less than $25 million
in insured property.

Damaged property must be located in the United States, its territories
and possessions, Puerto Rico, and Canada. As mentioned earlier,
the $25 million threshold applies to all related terrorist acts
(i.e., those carried out in concert, or with a related purpose,
or under common leadership) within a 72-hour period. And it applies,
once triggered, to all damage stemming from the terrorist act—not,
in other words, only to damage that exceeds the threshold.

The ISO terrorism exclusion that applies these restrictions to
property coverage exists in two forms: one that imposes the exclusion
absolutely, without regard to the nature of the property damage;
and another that makes an exception for direct loss or damage by
fire. This exception is mandated by law in certain jurisdictions
where property coverages of whatever type may not be more restrictive
than the provisions of the standard fire policy (SFP) recognized
by statute in that jurisdiction. (Standard fire policies insure
direct loss by fire regardless of the cause of the fire.) The exception
that applies in these so-called SFP jurisdictions applies only to
direct fire damage—not to any consequential loss (loss of income,
for instance) resulting from the fire.

In non-SFP states, the terrorism exclusion applies to property
losses without exception, including terrorist acts that cause direct
damage from fire. Figure 1 lists the SFP and non-SFP jurisdictions.
(This list refers only to the applicable law of the jurisdiction
and the form of the commercial property terrorism exclusion filed
in that jurisdiction. It is not a list of jurisdictions that have
approved the filing. Approval information is contained at the end
of this article.)

With respect to commercial general liability (CGL), the ISO "war
or terrorism" exclusion alters the policy's basic coverage considerably.
As pointed out above, the CGL war exclusion already contained within
the policy applies only to liability assumed in a contract. The
"war" portion of the new ISO endorsement, on the other hand, imposes
a sweeping exclusion of liability arising out of war and any "warlike
action," including defensive and preventive governmental actions,
and not limited to contractual assumptions.

The terrorism portion of the exclusion (the actual exclusionary
language and the definition of "terrorism") is the same as the property
insurance version, with two exceptions. First, the $25 million dollar
property damage threshold is not limited to property in the United
States and Canada; a total of $25 million dollars in property damage
anywhere in the world—arising out of one terrorism "incident"—will
trigger the exclusion. Since CGL coverage applies under certain
circumstances on a worldwide basis, the exclusion is made equally
broad.

Second, in light of the fact that liability claims may involve
either property damage or bodily injury, a "serious physical injury"
component is added to the trigger. The exclusion applies to liability
claims when a terrorist incident causes either $25 million of insured
property damage or the death of or serious physical injury to 50
people. As in the property exclusion, the threshold does not apply
to terrorist incidents involving nuclear, biological, or chemical
weapons. Liability stemming from terrorism using such weapons is
excluded regardless of the scope of the resulting injury and damage.

The liability exclusion applies both to bodily injury and property
damage under Coverage A of the policy; and to personal and advertising
injury under Coverage B. Medical payments coverage under the ISO
CGL is subject to its own war exclusion, which is absolute in much
the same way as the war component of the new "war or terrorism"
exclusion. When the latter exclusion is applied to the policy, the
basic medical payments war exclusion already in the policy is deleted.
But since medical payments coverage is subject to all exclusions
applicable to Coverage A, the "war or terrorism" exclusion, in effect,
will apply to bodily injury under medical payments coverage as well.

The general liability exposures related to terrorist acts are
still unclear, since lawsuits connected to the events of September
11 have been slow to emerge. Nonetheless, a number of potential
causes of action have been discussed in the media and among risk
management and legal professionals. Among the most frequently discussed
are claims of failure to warn of a possible terrorist act and negligence
in responding to the emergency conditions created by an actual terrorism
incident. Negligent hiring and supervision could also be the basis
for claims against an employer who provided an employee with the
opportunity or means to commit an act of terrorism meeting the exclusion's
threshold.

Approval of the ISO Filings

With the endorsement of the NAIC, the ISO terrorism filings have
won rapid approval by most state regulatory authorities, and are
already in use in the jurisdictions that have approved them. Another
policy-drafting and advisory insurance organization, the American
Association of Insurance Services (AAIS), has filed terrorism exclusions
for use with its commercial coverage forms that are equivalent to
ISO's and also conform to the terms approved by the NAIC. Moreover,
ISO has given permission to insurers not affiliated with it to use
the ISO filings, which means that the language of the ISO exclusions
should become an almost universal industry standard.

Forty-five states, the District of Columbia, Puerto Rico, and
Guam have approved the ISO filings. In each of those jurisdictions,
regulatory approval was granted with an effective date of January
1, 2002, except for Alaska, where the effective date was January
12. ISO expects approval in three additional states: Florida, Georgia,
and Texas.

Two states, California and New York, have refused to approve
the filings in their current form, and are pursuing discussions
with ISO about possible further amendments. The California Insurance
Department cited the following reasons for its refusal: (1) the
bodily injury and property damage thresholds are unreasonably low;
(2) the 72-hour definition of a single "incident" may be unfair;
(3) the total exclusion of terrorism involving biological or chemical
agents (without any threshold) is overly broad; (4) the exclusion
may have an anti-competitive effect. The New York Insurance Department
also voiced an objection that the $25 million threshold is too low.

In several of the states that have approved the ISO filings,
steps have been taken to put in place some form of "sunset" provision
governing use of the exclusion. These provisions would suspend the
applicability of the exclusions at some point (15 days, for example)
after federal action is taken to provide reinsurance or other financial
guarantees to insurers for terrorism claims. Additionally, in some
states, use of the ISO filing by an individual insurer is made contingent
on the insurer's documentation of a lack of reinsurance for terrorism
claims. ISO has stated that it will act promptly to review its terrorism
language in the event of federal action addressing the lack of reinsurance.

Conclusion

Given an insurance policy exclusion that applies only when terrorists
have killed or injured 50 people; or employed nuclear, chemical,
or biological weapons; or destroyed more than $25 million worth
of property, the only legitimate response is a fervent hope that
no insurer ever has occasion to use it. Beyond that, a wait-and-see
attitude seems especially appropriate with respect to this particular
coverage issue.

For those who question the reality of the "reinsurance crisis"
that has caused commercial insurers' concerns regarding terrorism,
some answers may come in those states that require insurers to prove
a lack of reinsurance before using the exclusions. Our sources indicate
that most of the reinsurance treaties that renewed in January indeed
do not cover terrorism. Another major round of renewals will take
place on July 1, and we expect those reinsurers will take a similar
stance at that time. This will, of course, affect insurers who rely
heavily on reinsurance more than those that do not.

With the reconvening of Congress on January 23, speculation has
renewed about federal action to provide the insurance industry with
some form of financial guarantee regarding catastrophic terrorism
claims. As discussed above, any ongoing use of the new ISO exclusions
is contingent in a number of states on the failure of the federal
government to enact so-called backstop legislation. And ISO itself
is committed to "responding promptly" to any federal program that
would make the exclusion unnecessary. In the meantime, commercial
insureds and their insurance and risk management advisers should
take a close look at the new terrorism exclusions; they just might
find one on their next policy.

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